Insolvency – What Does it Mean?

the moment when the company becomes unable to pay its debts as they full due. This is often referred to the cash flow test

the moment at which the company’s liabilities exceed the value of its assets. This is commonly referred to as the balance sheet test

Cash flow test

When it comes to avoiding insolvency proceedings cash is king. If a creditor asks for money and cannot be paid then under the cash flow test you are insolvent and at risk of being wound up. This fact does not change even if you are making a profit. At this point the twilight period commences and transactions entered into by a company are at risk to attack and/or the directors and others involved in the management of the company are at risk of incurring personal liability

Balance Sheet test

In addition to the liabilities recorded in your accounts other liabilities are taken into account in determining whether you are technically insolvent. The types of liabilities arise generally arise when the business stops trading, for instance breach of contract or redundancy liabilities and other employee entitlements which can be very significant for a long standing company with loyal staff.

QUESTIONS

Can directors incur further credit during the twilight period?

If insolvency has been determined or there is a possibility of insolvency then the directors overriding duty is to the company’s creditors as it is the creditors money which is now at risk and not that of the shareholders. If there is not a reasonable prospect of the company avoiding insolvent liquidation then the directors must do everything to minimise the loss to creditors. Incurring further credit may be seen in some instances to be fraudulent but there is a balance to be met between what a reasonable business man would do for the benefit of the company and its creditors, and on the other hand, the act of exploiting and continuing a business at the expense of creditors. There is no easy answer. Before acting consult our Insolvency and Corporate Recovery experts.

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